PulteGroup's (PHM) CEO Richard Dugas on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: PulteGroup, Inc. (PHM)

PulteGroup, Inc. (NYSE:PHM)

Q2 2014 Earnings Conference Call

July 24, 2014 8:30 AM ET

Executives

James P. Zeumer – Vice President-Investor Relations and Corporate Communications

Richard J. Dugas, Jr. – Chairman, President and Chief Executive Officer

Robert T. O’Shaughnessy – Executive Vice President and Chief Financial Officer

James L. Ossowski – Vice President-Finance and Controller

Analysts

Michael Rehaut – JPMorgan Securities

Ivy Zelman – Zelman and Associates

David Goldberg – UBS Investment Bank

Eli Hackel – Goldman Sachs

Stephen East – ISI Group Inc.

Nishu Sood – Deutsche Bank North America

Stephen Kim – Barclays Capital

Kenneth R. Zener – KeyBanc Capital Markets Inc.

Robert Wetenhall – RBC Capital Markets LLC

Adam P. Rudiger – Wells Fargo Securities LLC

Will Randow – Citigroup Global Markets Inc.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

James Krapfel – Morningstar Research

Dan M. Oppenheim – Credit Suisse Securities LLC

Buck Horne – Raymond James & Associates

Operator

Good morning. My name is Anastasia and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup, Inc.’s Second Quarter 2014 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Jim Zeumer, you may begin your conference.

James P. Zeumer

Great. Thank you, operator. This is Jim Zeumer, Vice President of Investor Relations for PulteGroup, and I want to welcome everyone to our call this morning to discuss our second quarter financial results for the three months ended June 30, 2014.

On the call today to discuss our results are Richard Dugas, Chairman, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO; Jim Ossowski, Vice President, Finance and Controller.

Before we begin, I want to remind everyone that copies of this morning’s earnings release, along with the presentation that accompanies today’s call, have been posted to our corporate website at pultegroupinc.com. Further, an audio replay of today’s call will be available on the site later today.

Please note that today’s presentation may include forward-looking statements about PulteGroup’s future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today’s earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports.

Now let me turn the call over to Richard Dugas. Richard?

Richard J. Dugas, Jr.

Thanks, Jim and good morning everyone. I’m extremely pleased with PulteGroup’s second quarter results, which show a continuation of a positive company and industry dynamics we discussed as part of our first quarter conference call and more broadly over the past 12 to 18 months. Within the U.S. housing market that remains on a steady recovery path, we are benefitting from company’s specific initiatives that continue to generate gains and key financial metrics, consistent with our value creation strategy.

Reflecting with an ongoing recovery and demand, and overall favorable pricing environment, the value of our second quarter signups increased by 5%, as we once again realized the improved absorption paces over last year, we see these as positive signs for our business going forward.

As Bob will detail among the promising aspects of these gains, it is a meaningful increase in the performance of our Centex communities and the implications for potential future demand among entry-level buyers. It has been widely reported that the first time buyer has been underrepresented in this housing cycle. So improving demand at Centex communities is a very encouraging sign.

We also realized the solid increase in sales pace within our Del Webb communities. As we have talked about before, there is tremendous operating leverage to be realized with volume, so continued gains in Webb’s absorption pace is important.

Within this demand environment, we continue to focus on maximizing profitability on each norm we sell. Consistent with this strategy, we realized a 12% increase in average selling price over the last year, along with favorable market conditions on our ongoing mixed shift, price gains were generated through specific pricing strategies that address everything from base house and option pricing to lot premiums and discounts.

Each is a dial; we can adjust to accommodate biogroups and local market conditions to help us achieve our goal of higher returns on invested capital in each community we operate. For the better price realization and initiatives to drive more efficient ongoing operations, we were again, successful in raising reported gross margins.

On a year-over-year basis, gross margin for the second quarter increased by 480 basis points to 23.6%. In fact, we have to look in history books all the way back to 2005 for these type of margins from PulteGroup. We are of course, pleased with the improvement in gross margin that we have been – we have generated in 2014, as well as over the past several years and see opportunities to continue the strength going forward.

Through a combination of pricing strategies, gains in operating efficiency and savings associated with lower interest costs, we see the potential for incremental gross margin improvement from here.

An insurance related charge taken in the quarter makes the year-over-year gains in our homebuilding operations a little harder to appreciate when you see earnings of $0.11 per share, up a $0.09 per share last year. However, when you adjust for the charges taken in both periods and the more normal tax rate in 2014, the meaningful and sustained improvement in our homebuilding operations is clear.

Given the gains we have realized in operating and financial performance, we are comfortable increasing our level of investment into the business, confident that we will be able to generate better returns on invested capital that we were delivering in the past. roughly 400 million of land spend for the quarter and 720 million for the first half of 2014 is the most we have invested in a number of years.

The increased investment is possible given our more efficient homebuilding operations and strong balance sheet, and it’s consistent with our view of an ongoing recovery in housing demand. So our headwinds facing the housing industry including type credit availability, and in our view, the negatives are outlaid by the positives, such as the monthly jobs reports showing an economy generating more jobs than it had in the recent past.

Interest rates remaining low, even a lot of that continues to withdraw support from the system and inventories of new and existing homes remaining imbalance with reports about an under supplier product in some areas of the country. These conditions in content with a good pricing environment and continued increases in apartment lease rates, support our expectation for a continued albeit measured recovery in housing demand.

Now, let me turn the call over to Bob for more details on the quarter. Bob?

Robert T. O'Shaughnessy

Thank you, Richard, and good morning. PulteGroup’s second quarter results demonstrate further success operating against our value creation strategies and driving improved operational performance and financial results. As I will detail, these improvements are evidence in our Q2 numbers.

Looking at our income statement, wholesale revenues in the second quarter were $1.2 billion, which is an increase of 2% over the comparable prior year period; the higher revenues for the quarter were driven by a 12% increase in our average selling price to $328,000, partially offset by a 9% decrease in our closings to 3,798 homes.

Consistent with recent quarters, we realized price increases at many of our communities and within each of our brands. For the second quarter, the 12% average increase in selling prices included a 13% increase to $396,000 in our Pulte communities, a 9% increase to $325,000 in our Del Webb communities and a 3% increase to $202,000 in our Centex communities. We continue to experience a shift in the mix of homes closed to move-up and active adult product.

For the second quarter, 45% of closings were from Pulte communities, 32% were from Del Webb and 23% were from Centex. in Q2 of 2013, the mix of closings was 46% Pulte, 27% Del Webb and 27% Centex.

Our reported gross margin for the quarter was 23.6%, which represents a gain of 480 basis points, compared with last year. Our margins benefited from the higher prices and mix shifts, I noted as well as lower interest cost. I think it’s important to highlight that we believe our margins are being enhanced by our strategic pricing model, which seems to maximize lot premiums and option dollars within the final selling price of the home.

We continue to realize gains through this initiative as lot premiums and option revenues per closing in the second quarter increased by 23% and 14% respectively to $12,000 and $47,000 per unit. Also supporting the expansion margins was a reduction in sales discounts, which dropped 90 basis points from last year to 1.7%. In dollar terms, discounts were only $5,700 per home, down from $7,900 last year. We’ve highlighted that we don’t expect discounts to decline significantly from these levels.

Along with capturing pricing opportunities, we continue to expand our use of commonly managed plans to help insure that we’re building the best home for the lowest price. In the second quarter, 39% of our deliveries were from commonly managed plans. This is an increase from the 30% we reported in the first quarter. We’re extremely pleased with our progress on this metric as we have grown this percentage from just 13% one year ago. We are clearly on track to meet or exceed our goal of 40% of our closing from commonly managed plans by the end of 2014.

Given the benefits of commonly managed plans, a favorable pricing dynamics were experienced in the market and the impact of our deleveraging the balance sheet over the last few years. We continue to see opportunity for further margin expansion from here although there will be volatility from quarter-to-quarter. Based on our current backlog, we expect the margins for the balance of the year to be consistent with that’s slightly higher than our margin this quarter.

SG&A costs for the second quarter were $230 million, or 18.4% of home sale revenues, compared with $151 million, or 12.3% last year. The year-over-year increase in SG&A was primarily driven by a charge of $84 million, reported in the quarter for increased insurance reserves.

The adjustment to our reserves was driven by costs associated with siding repairs in certain previously completed communities in the west. Beyond the direct cost of the repairs, the negative development in the period to use the insurance filing impacted our actuarial estimates for incurred, but not reported for potential future claims, the combination of higher costs incurred and the resulting increase and estimates for future expenses throughout the second quarter charge. Repairs are in process in the impacted communities and we’re working with homeowners and contractors to ensure the work is completed efficiently, and with minimal disruption to the residence.

Excluding this charge, SG&A costs in the period were consistent with expenditures in Q1 of this year and with previous guidance. Financial services reported pretax income of $9 million for the quarter, compared with $16 million in Q2 of last year. The reduction in pretax income for the period was the result of lower origination volumes and the more competitive operating conditions that continue to exist within the mortgage industry.

Capture rate for the period was unchanged from last year and consistent with Q1 of this year mortgage put back request remains at very low levels. Inclusive of the $88 million in charges for insurance and office relocation costs, pretax income for the second quarter of 2014 was $58 million. Prior year pretax income of $38 million included charges totally $67 million for contractual dispute, debt repurchases and corporate relocation.

As you can see, our operating performance excluding these items was significantly improved. Income tax expense for the period was $26 million, or an effective tax rate of 38%. This is consistent with our previous guidance and taxes in 2014 would be approximately 39%. Prior year tax expenses only $2 million, or an effective tax rate of only 5% that the company is yet to reverse deferred tax asset valuation allowance.

Net income for the second quarter was $42 million, or $0.11 per share including $0.14 per share of charges recorded in the period. For the second quarter of 2013, net income was $36 million, or $0.09 per share, including charges of $0.17 per share. Again, this year’s net income reflects the 38% tax rate, compared with the 5% rate last year.

Looking at other operating metrics, we have 6,321 homes under construction of which 15% were spec at the end of the quarter. Spec reduction is consistent with prior year and prior quarter, but particularly important; however, finished specs sold less than 300 houses, or well below one per community.

During the quarter, we put 6,700 lots under control and invested $395 million in land acquisition and development. we approved more deals in the quarter than we have in any quarters since 2006, including the approval of three new communities to serve future active adult buyers, continuing recent trends about three quarters of the deals are raw meaning that land development is required. So these transactions will support production in 2016 and beyond.

We had 126,000 lots under control at the end of the quarter, of which 26% were controlled via option, 24% of the lots under control are finished, and we have another 18% under development. At $395 million for the quarter, our land spend is clearly increasing. For the year-to-date period, we have spent approximately $720 million. We continue to target a full year land spend of $2 billion for 2014, or recognize it will be a challenge to spend an additional $1.3 billion over the next six months.

As we’ve highlighted before we are comfortable with this, we continue to invest in a disciplined manner with a focus on better located positions and acceptable risk adjusted returns. It’s important to note that we continue to see good opportunities, as evidenced by the level of spend we approved during the second quarter.

along with our higher land investments, we have also increased our repurchase activity in Q2. In total, we acquired 2.8 million shares for $53 million, or $19.12 per share. As of June 30, 2014, we had $137 million of capacity remaining under our share repurchase authorization.

We ended the quarter with $1.3 billion of cash on the balance sheet. I would also highlight that we entered into a new three-year $500 million unsecured revolving credit facility yesterday. the revolver, which includes an uncommitted accordion feature that could increase the facility to $1 billion, replaces a letter of credit facility that have set to expire later this year and provide data financial flexibility for the company.

Moving past our financial statements, the dollar value of signups in the quarter increased 5% over the last year to $1.6 billion. On a unit basis, net new orders totaled 4,778 homes, which is down just 2% from last year, despite a 6% decrease in community count. As Richard highlighted, this is the second quarter in a row where we experienced higher absorption paces. Looking at this by brand, net signups decreased 1% at Pulte, and 5% at Centex and 2% for Del Webb.

Q2 absorption paces were down at 8% at Pulte, but up 11% at Del Webb and 26% at Centex. A 26% increase at Centex solves a 29% improvement in year-over-year absorptions in the first quarter of this year, certainly part of the increase is driven by the overall strength of demand in Texas. but the trend in Centex weren’t close monitoring and there may be a growing opportunity with the entry-level buyer.

We ended the quarter with 589 communities, which is a decrease of 6% from the end of last year. Q2 community account was flat with the first quarter of this year and in line with guidance that we expected to operate from approximately 560 to 580 communities throughout 2014. The stability across the headquarters hides a fact that this is a very active year, which we plan to open approximately 190 new communities over the full year. Our quarter end backlog with 8,179 homes valued $2.8 billion, which compares with prior year backlog units, and dollars of 8,558 and $2.7 billion respectively.

The average price of our homes and backlog is up 7% over the last year to $339,000 and up from $336,000 in Q1 of this year. Overall, I am extremely pleased with our results for the quarter even more encouraging our improving absorption paces with better pricing, growing margin and increased investment put us in a very strong position moving forward.

Now let me turn the call back to Richard for some final comments.

Richard J. Dugas, Jr.

Thanks, Bob. As Bob just detailed we continue to experience strong buyer demand in the quarter which generated increased absorptions and allowed us to realize higher selling prices. While we appreciate that housing data can be volatile from month-to-month, we’d remain optimistic about overall conditions and very encouraged demand through the first six months of the year.

Looking at conditions in the second quarter on a more regional basis, on the east coast conditions didn’t changed all that much in the first quarter this year. In that activity was stronger as you move from the north to the south. Buyer activity remains particularly strong in Carolinas, and throughout the State of Florida.

Market conditions in Washington DC however were still challenging in the quarter. Conditions in the middle part of the country were positive in the second quarter, similar to our experience on the East Coast demand strengthened as you move from north to south. Texas remains one of the strongest areas of the country with exceptional demand across all markets of Dallas, Houston, Austin and San Antonio. Relative to the first quarter of the year demand conditions got better as we move past the tough winter.

Finally, moving to our western markets the patterns of the past several quarters continued as we experienced strong demand in Northern California and Pacific Northwest, well our markets in the Southwestern states of Arizona, New Mexico and Nevada are good, but not as strong as this time last year. As the U.S. economy continues to improve we would anticipate that these markets will benefit.

In terms of demand for the first few weeks of July, we have seen the typical summer slowdown, but the market specific trends we experienced through the first six months of the year are generally unchanged.

In closing my thanks to all of our employees who are working extremely hard to help us drive our improved operating results and we are doing an amazing job opening 190 new communities this year. Thanks for your time this morning and I’ll now turn the call back to Jim Zeumer. Jim?

James P. Zeumer

Thank you, Richard. At this time we will open the call for questions, so that we can speak with as many participants as possible during the remaining time in this call. We asked that you limit yourself to one question and one follow-up. And Anastasia if you’ll explain the process, we will get started.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Rehaut with JP Morgan. Your line is open.

Michael Rehaut – JPMorgan Securities

Thanks, good morning everyone and nice quarter.

Richard J. Dugas, Jr.

Thanks, Mike.

Michael Rehaut – JPMorgan Securities

The first question I had was your comments on Centex and the continued positive sales pace, you mentioned part of it was driven by Texas and I just wanted to get a sense of its sales pace was up in the other regions where Centex is more dominant or how much really Texas was responsible for this and part of this is – is just a reformulation or mix benefit from some newer communities as well?

Richard J. Dugas, Jr.

Yes, Mike this is Richard. It’s a combination of Texas and other markets, to be clear the entry-level does appear to be improving in other markets as well. We happen to have the biggest percentage of Centex communities in Texas, and as everyone knows the job growth in Texas is strong that’s why we highlighted, but it appears to be a broadening improvement for the entry-level categories?

Michael Rehaut – JPMorgan Securities

Okay. And just secondly the gross margins continue to be great and you’ve showed a lot of improvement there, one of the competitors this morning mentioned that they’ve maybe taken some actions to improved sales pace in the market, which might suggest a modest negative impact on gross margin. Is this something that you think might continue going forward and kind of spread to the industry or have you seen this from a competitive standpoint – by other builders or in certainly other markets?

Richard J. Dugas, Jr.

Mike, we are definitely to run on the company for the highest returns on invested capital and we are not pushing discounts as a matter of fact, as Bob indicated discounts drop year-over-year to an incredibly low level, while lot premiums and option revenue increased. So, I can’t speak to what competitors are doing? I am not seeing broad-based discounting across the board. I think inventory levels candidly are too low and I would point out that the very strong quality land, that we have been buying the land several years, along with our return strategy is supporting our higher margins. As Bob indicates we expecting to continue.

Operator

Your next question comes from the line of Ivy Zelman with Zelman and Associates. Your line is open.

Ivy Zelman – Zelman and Associates

Good morning, guys. Congratulations on another strong quarter.

Richard J. Dugas, Jr.

Thanks, Ivy.

Ivy Zelman – Zelman and Associates

If you could just please talk to a little bit – with the charge reserves on the $90 million for the siding, this is completely separate from the construction defects that you reserve for few years ago. And, just understanding making sure that separate, and then, my follow-up is just as you thinking about the mortgage competitive, mortgage environment. What are you seeing more in terms of lenders willingness to maybe remove some of the credit overlays. As you deliver loans to Fannie and Freddie is the consumer actually seeing a better price as a result for the competitive pressures and maybe more specific within the credit buckets, recognizing that you are typically dealing with the better quality borrower, but you’ve also indicated the Centex, this is picking up, so is that a function and also lending improving to that bucket. Thanks and congratulations again.

Richard J. Dugas, Jr.

Okay. Thank you. So, Bob do you want to take the first part.

Robert T. O'Shaughnessy

Sure. So the charge IVY is for siding issues and it is construction defect work. So, we are repairing siding issues that we have identified and the mechanics of this are, we’ve got certain communities where we have costs and then looking at the actuarial analysis. When we saw that activity the actuaries look at that and say okay, if we see it today, we have to extrapolate across the universe of production. So, it is actually both specific to certain communities siding issues and then a extrapolation for incur but not reported plans.

Richard J. Dugas, Jr.

Okay. And then, Ivy, with regard to the mortgage environment, I would say credit appears to be easing just on the margin on the edges if you will, I do believe that is some of the improvement in the entry level, I do think however, the majority of the improvement in the entry-level is job growth related. I don’t think credit has moved much, but it appears to be easing just on the edges, we’ve seen a very slight increase in credit availability as measured by MBA in their statistics.

Ivy Zelman – Zelman and Associates

Great. Thanks, guys.

Richard J. Dugas, Jr.

Thank you.

Robert T. O'Shaughnessy

Thank you.

Operator

Your next question comes from the line of David Goldberg with UBS Investment Bank. Your line is open.

David Goldberg – UBS Investment Bank

Thanks, guys. Good morning.

Richard J. Dugas, Jr.

Good morning, David.

David Goldberg – UBS Investment Bank

My first question, I want to follow-up on one of the Bob’s comment earlier about kind of where, what’s happening in the Centex business segment and the higher absorption rate and the trend, keeping an eye on the trend. What I am trying to get an idea is, what’s the trigger points for you guys to start maybe focusing more land acquisition on Centex communities? Is that you hit a certain absorption paces is a certain confidence in the economy. What are you looking for when you are examining that trend and the improvements you are seeing to get more confident in your land acquisition in that segment?

Robert T. O’Shaughnessy

The simple answer is as you heard Richard say it is return, so as we look at land transactions in the market, that the teams are agnostic to brand and so they’ve got opportunities to invest in any one of our brands. And so I think what would drive increased investments in Centex is a continuation of the pace increases if you are seeing here, because it still has lower ASP’s, still has lower margins. And so we need higher paces, so it would be that improving environment for the buyer and Texas is a great example that job market there is really strong, Richard highlighted this, strong jobs are driving consumer confidence and that buyer is therefore buying in more volume and so you would see us invest more in that land when we see that activity.

David Goldberg – UBS Investment Bank

That’s great color. My second question was on the three new active adult communities that were I think put under contract you mentioned earlier in the commentary. Can you give us just a kind of high level are these replacement communities for things that are rolling off, these incrementally and what might be different or maybe the same about those relative to the existing Del Webb communities if you kind of look at the rolling off and rolling off pattern?

Robert T. O’Shaughnessy

Great question, these are largely the replacement communities there is one that is a fresh community, what I think you see different from the historical Del Webb is they are smaller they range and size from 600 units to 1,200 units, we think we will be in and out of them and say five years it will have a slightly smaller aminity package to what I – you probably heard me refer to as the crew shift Del Webb, if its continuation on an existing community it may have of shared aminities but typically, we had a club house it might not have a golf course any more, it will have walking trials. So again a little bit smaller and I think we’ve talked about this for a couple of years those 5,000 unit communities are likely not featured,

Richard J. Dugas, Jr.

David, everything Bob mentioned, is all driven around return its all part of the Pulte story.

David Goldberg – UBS Investment Bank

Great, thank you guys. Nice quarter.

Robert T. O’Shaughnessy

Thank you.

Operator

Your next question comes from Eli Hackel with Goldman Sachs. Your line is open.

Eli Hackel – Goldman Sachs

Thanks and good morning. I just wanted to go back to the first time buyer and credit for a minute or so, Richard you talked I maybe think using on the margin, is there anything else you can see over this next six, nine months whether its conversations in the industry with your mortgage trends with people and do you see or maybe that change more, maybe that would change more incrementally and then also on the first time buyer. Do you think there is any holdback of them buying due to lack of available supply in the market so it’s really much more back to your first one which is really job growth accelerating within that core buyer? Thank you.

Richard J. Dugas, Jr.

Yes. So I will answer and a reverse Eli, I think the majority of a problem is a combination of tight credit and jobs the combination there, overall, I don’t think there is a lack of supply for that category, I think the industry can ramp up to build for that category, on there is certainly some supply shortages but the majority of the issues I believe are tight credit and jobs. With regards to credits potentially easing from here mortgage finance reform legislatively is likely dead for this year as I think everyone knows the job’s in (indiscernible) didn’t make it too far in congress, so we are working as a group of collective large builders to push the administration particularly to work on administrative solutions to the credit box, which we do believe can have some impact that would be things like changing FHA fees things like that. Unfortunately, that’s the sometimes tough to get done and I do believe that will take sometime, but by clarifying a put rules by insuring that the definition of qualified mortgages and qualified residential mortgages is very clear by focusing on FHA fees, things like that we do believe there is some administrative actions that know what could take, as he heads up FHFA would be outside of legislative arena. And we are working on that, we are not holding our breath at, anything is going to happen dramatically to help that. It’s going to take sometime for credit to years in my view.

Eli Hackel – Goldman Sachs

Great, thank you very much.

Richard J. Dugas, Jr.

Thank you.

Operator

Your next question comes from Stephen East with ISI Group. Your line is open.

Stephen East – ISI Group Inc.

Thank you, good morning guys.

Richard J. Dugas, Jr.

Hi, Stephen.

Stephen East – ISI Group Inc.

Richard you talk a little bit about the July rebound or is it July being pretty normal seasonally and we’ve heard from various places that June absorptions were down like 15% across the industry et cetera. Could you talk about how your order progression was during the quarter and whether you saw that type of absorption drop in the quarter?

Richard J. Dugas, Jr.

Yes, Steve. We saw fairly seasonal typical trend. And April and May were stronger than June. We didn’t see a dramatic fall off in June it was very typical summer seasonal which is continued into July.

Stephen East – ISI Group Inc.

Okay. And then we’ve also heard over the last three or four months that generally traffic it’s been much better than the conversion into orders, I was wondering if you all were seeing that and then if I could just ask one question back on the gross margins. Can you help me reconcile a little bit the commonly managed four plans jump from 30% to almost 40% that the gross margin stayed about flat? How do we reconcile those two and is that going to be an ongoing thing there.

Richard J. Dugas, Jr.

Okay, I’ll take it crack it both and then maybe Bob might want to add any color. On traffic versus conversion, we are continuing to see good traffic and conversions respectable I would just again say within the balance of a typical summer slowdown. So not a lot of movement Steve either way on either metrics I would say we still had good traffic and respectable conversion both marginally down given the summer season. On gross margin performance the commonly managed plans or better margin product and we are excited about the 39%, but many things go into the margin performance including specifically mix for the quarter. And we have indicated that we would have quarter-to-quarter volatility, our margins even though they were sequentially down I think about 20 basis points they continue to be at a very high range and as Bob indicated based in our backlog we see opportunities in next couple of quarters in them to be in this range or slightly higher from here. So we’re pleased with our overall margins and mix influences things from quarter-to-quarter. I don’t know Bob any other color.

Robert T. O'Shaughnessy

I only things I want to add is, one things that we’ve highlighted about these commonly managed plans that we think is sort of the hidden gem, is that our absorption paces are higher with them. And I think its contributing to the absorption pace increases you are seeing from us, which is equally as important to return for us the margins.

Operator

Your next question comes from Nishu Sood with Deutsche Bank. Your line is open.

Nishu Sood – Deutsche Bank North America

Thanks and good morning. First question I wanted to ask was about the profile of land spend, you folks mentioned that you approved the most number of deals I think in, since maybe and going back to the housing boom, but at the same time you also said that $2 billion land authorization, it will be tough to get there. So I was just trying to reconcile those two, does that imply that, you’ve shifted your land purchases towards much longer deals, where the cash flows are more back end weighted or is that, just a reflection of the fact that the trajectory of housing this year is probably turned out to be a little bit slower than most of us originally expected.

Robert T. O’Shaughnessy

Yes, I would actually characterize it is that the change to a certain degree in what we are buying, there isn’t much finished lot availability out there. So we’re buying raw land, and so while our dollars out the door today, it will be a challenge to get the $2 billion; we’ve actually committed a fairly significant amount in terms of what will develop in 2015 and 2016.

So you’ll see spending increasing in out years because of what we’ve done this year. And we think we’ll get close to the $2 billion, we are just not sure we’ll get all the way there. And it’s because we’ve continued to tell our folks don’t chase deals. This is you’ve got authorization to go spend money, but don’t do it foolishly. And so the discipline that they are exhibiting is going to make it a little bit of challenge to get the $2 billion, but you’ll still see a significant increase over fiscal 2013 and we like the land that we are buying.

Richard J. Dugas, Jr.

Nishu, it’s Richard, I want to add two things what Bob said. Number one, we are seeing some delays in entitlement and municipal issues which candidly or somewhat out of our control just based on processing times to get things through the cycle and that’s causing some of the delay.

And secondly, I want to be crystal clear, we are not lengthening the land supply in a profile of the deals we are doing as a matter of fact. We are doing our best to make them strong returners, which generally means a little bit shorter positions clearly than the company is buying in the past. So there is no change in our profile over the last two or three years that we’ve been indicating ROIC first.

Nishu Sood – Deutsche Bank North America

Got it. Great. And kind of following up on that, 190 new communities I think you mentioned I think you’ll be opening this year. So a significant amount of turnover as well as accelerate pace of taking land under control. So do we begin to see a more significant pace of community comp expansion in looking into 2015?

Robert T. O’Shaughnessy

Nishu, we haven’t commented on that yet, and we are sticking with our guidance of 560 to 580 for this year and as we get closer into either late Q3 or Q4 we’ll provide some guidance for 2015. But it’s too early for us to speculate on those numbers.

Operator

Your next question comes from Stephen Kim with Barclays. Your line is open. If you are on mute, please unmute.

Stephen Kim – Barclays Capital

I’ll apologize for that. I was muted. Thanks very much for the color, the quarter, interesting about the entry-level would set to see where that goes. I wanted to ask you a question about labor and the ability to construct homes, particularly I’m interested we all know that labor shortage is that been something that the builders have talked about for kind of while and obviously there is cyclical cycle reasons associated with the severity, the downtrend that have made labor and particularly short supply. My question is, is there – is it more difficult or more easier to get labor to build your entry-level product versus some of your higher end products. And specifically what I’m getting, do you see a recovery in the entry-level demand? Do you anticipate that labor shortages will constrict your ability to meet that demands with product? Or is it because or could it be that because entry-level homes don’t maybe required the same amount of finished skills, trend and so forth that actually you can take some lesser skilled labor and still get those homes build at the entry-level?

Richard J. Dugas, Jr.

Steve, we’re not seeing any difference in labor availability for entry-level versus a more luxury focused product for us. I’ll say labor is tight in the industry particularly for unskilled trades, drywall, looping and things like that. And clearly there is some constraint on ability to close backlog in the near-term; it’s just a timing issue. So you may have units moved from one month or one quarter to another. So I don’t think it’s a big problem for the industry, but it could cause some minor disruptions frankly not unusual from past recoveries, but no not a lot of change in segment availability of labor.

Stephen Kim – Barclays Capital

Okay, that’s encouraging, great. And then you made a comment in your prepared remarks about land and I just want to make sure that I got the numbers. You mentioned I think that 24% of your lots were finished. I wanted to make sure I understood was that the owned, 24% of owned lots or 24% of your controlled lots. I want to know how many owned finished lots you have?

Richard J. Dugas, Jr.

It was controlled Steven, and we’ll see if we can get that number for you. We had 24,683 finished owned lots.

Stephen Kim – Barclays Capital

Thanks.

Richard J. Dugas, Jr.

Which would be 27% of all finished lots we have.

Stephen Kim – Barclays Capital

20% of all….

Richard J. Dugas, Jr.

All right, 20% of all owned lots. Sorry.

Operator

Your next question comes from the line of Ken Zener with KeyBanc. Your line is open.

Kenneth R. Zener – KeyBanc Capital Markets Inc.

Good morning, gentlemen.

Richard J. Dugas, Jr.

Good morning, Ken.

Kenneth R. Zener – KeyBanc Capital Markets Inc.

Richard you talked about approvals impacted, you commented on approval process impacting your land spend. Could you comment on what the discipline side i.e. your returns says about what land prices are in various markets, this is my first question.

Richard J. Dugas, Jr.

Yes, Ken, we’ve certainly seen a significant escalation over the past 12 months to 18 months in land prices; they do appear to be moderating to some degree. However, I would tell you that the discipline that we are exhibiting with a very capital constrained focus internally to drive higher returns continues to lead us toward challenges to meet the overall lands and goals that we have. As Bob indicated we hope to get to the $2 billion level, but we are not going force it. So overall we are pleased with our discipline, we think it served as well, we think it’s one of the reasons that our margins have held up as well as they have. And frankly one of the reasons our paces are doing well simply because of the quality of the land we are buying. So continued more of the same I would say is in our future.

Kenneth R. Zener – KeyBanc Capital Markets Inc.

Okay, and than my second question broadly related how you are running the capital structure. Could you give us a sense of what you think the company will do, if your revenues are growing let say 10% or X%? What is the cash flow cycle imply about your yield or your free cash flow generates the potential, the buyback stock as you did – as you did in the quarter given that you are not going to be a cyclical on the capital investment cycle.

Robert T. O’Shaughnessy

Yes. It’s a great question, Ken and as a company, we continue to – we think to exhibit balance with our capital allocation strategy and I think you can expect more of the same from the company, we reintroduced the dividend last year to a reasonably nice level and we stepped up our share repurchases in Q2. And so I would expect the company to continue to exhibit balance. Now that our returns were strong as they are, our first priority will be to put it in the business. But candidly, we don’t want to delude our returns. So we want to make sure that we’re buying the right lands.

So I think it’s fair to say, we’re going to have plenty cash available to do a multitude of things, and I would suggest that continuing to return funds to shareholders through dividend and buyback is likely in our future as part of our balanced process.

Kenneth R. Zener – KeyBanc Capital Markets Inc.

Right. And I guess, if you think about invest in the business like you said, and you’re going to be holding land and let’s say two-year. How do you gauge your discipline relative to what you want to invest today, based upon where you think the market is going to be because that’s the real thing, right. We have two-year, 50% growth, that’s different than a steady 10% or 15% growth which will yield us different element of cash flow? Thank you.

Robert T. O’Shaughnessy

Yes, I think it’s tough to predict that on the future too far, Ken. I would suggest for the near to medium-term, we like the conservative pasture that we’ve taken and we’ll, we realize that the large cash balance is a non-earning asset and we’d like to deploy it, we just don’t want to do anything dramatic or sudden to try to tie in the market if you will. So stay tune for further clarity and commentary on that as the picture become little clear in the future for us.

Operator

Your next question comes from Robert Wetenhall with RBC Capital Markets. Your line is open.

Robert Wetenhall – RBC Capital Markets LLC

Hey, good morning guys, a nice quarter.

Richard J. Dugas, Jr.

Thanks, Robert.

Robert T. O’Shaughnessy

Hi, Robert.

Robert Wetenhall – RBC Capital Markets LLC

How much – what’s your upside do you think there is gross margin, the standardized floor plans have been fantastic, very positive impact. Do you still see opportunity for upside?

Richard J. Dugas, Jr.

Bob, we indicated for the next couple of quarters. We see things in this range are slightly improved. Beyond that long-term, we don’t want to provide a lot of guidance, we certainly like the benefit from commonly managed plans, we like our discipline, but I’ll highlight something that Bob indicated is certainly a nice margin story and we want to keep it going, but it’s about return for the company. So we’re going to continue to make good decisions based on return overall. So we like where margins are headed for the foreseeable future.

Robert Wetenhall – RBC Capital Markets LLC

That’s helpful. You’ve been in the homebuilding industry for a long time. Do you think we’re transitioning from early cycle to mid cycle of the recovery? If you could just kind of give us your view where we are in terms of the evolution in that process? that would be great. Thanks.

Richard J. Dugas, Jr.

Yes, I think housing has several good years ahead. I don’t think we’re mid-cycle yet, frankly in my view. But I do think it’s a slow and steady path upward from here, I’d like to tell our folks internally my best projection is that I don’t see anything causing a sharp increase in overall demand, nor do I see anything causing a sharp decrease in demand. I think a slow and steady recovery is the most likely one, which is kind of what we’ve seen. There are a couple of headwinds that we historically might not have had in housing recovery, such as job growth that is good, but not great anti-credit, but the same token, those things appear to be getting better slowly, but surely. So that would be what I would expect.

One other thing Bob just mentioned is that the recovery now appears to be taking on regional and local geographic characteristics, which is very typical of a normal housing recovery. I think we transitioned probably late last year, or early this year from the sort of macro view, or housing was horrible for several years, and then we had a couple of years where housing was really good everywhere. Now, it’s becoming much more about local economies and local geographies, and that’s normal. So as we indicated, Texas has got great job growth, and it’s strong and DC has got social job growth and it’s not as strong, that feels normal to us. So again, to summarize slow and steady from here is my best guess for many years.

Operator

Your next question comes from Adam Rudiger with Wells Fargo. Your line is open.

Adam P. Rudiger – Wells Fargo Securities LLC

Hi, thanks for taking my question. Richard, in the last couple of questions, you’ve mentioned returns a lot, I was wondering if you could, in one particular, you said returns are strong now. So I just wondering if you could be even more specific and talk about what you’re referring to whether it’s something margins, or if it’s ROEs, or ROICs and what – where you are versus where are your targets and what might be achievable?

Richard J. Dugas, Jr.

Yes. We are clearly focused internally on our invested capital. So, it’s ROIC that I’m referring to, and all of our folks in the field I’ve been running the business. this is the fourth year in a row, with a focus on a combination of margins, SG&A leverage and asset turns. And if you kind of put that in the triangle, right in the middle of it, we’d kind of stamp ROIC.

so we feel like our returns are very strong today, and we feel like we can keep them in this range, or higher from here. We don’t think that our balance sheet is completely being utilized. In other words, we still have a number of lots that are long positions. and as we cycle through those, and we replace them with more term friendly deals. I think that can help the denominator, and obviously, we’re working on the numerator as well.

So, it’s hard to predict where returns can go, but we intend to be a high return in builder through the cycle, certainly, not as higher returns in the down cycle, as in the up cycle. but we want to be focused on returns from here on now, because we do believe that metric is the most important metric to drive shareholder return over the long run.

Adam P. Rudiger – Wells Fargo Securities LLC

Okay, thanks. Most of my questions have been answered.

Operator

Your next question comes from Will Randow with Citigroup. Your line is open.

Will Randow – Citigroup Global Markets Inc.

Hey, good morning, guys and thanks for taking my question.

Richard J. Dugas, Jr.

You bet, Will.

Robert T. O’Shaughnessy

Hey, Will.

Will Randow – Citigroup Global Markets Inc.

Hey, in regards to your land spend, are you guys kind of augmenting that towards Texas and Georgia versus some of the stronger markets. I think we are seeing, I don’t know if you are as well?

Richard J. Dugas, Jr.

We actually focus our investment on a couple of things. One is to maintain relative market share and the markets where we operate. The other is obviously where we see the opportunity for increased investment. So it will be a function of how well they’re investing today. We don’t say okay, if we’re going to invest 100 in total ex-percent goes here, here, here, it’s static. It actually moves over time. so certainly, the improved operating environment in Texas is one that has interested in investing more. So they have a fair amount of capital. But we are trying to maintain relative market share in all of the markets where we operate.

Will Randow – Citigroup Global Markets Inc.

Thanks for that. And then just in terms of, on the balance sheet, give me some of credit metrics, do you intent to refinance your 2015, 2016 maturities from Centex. and I guess overall is your goal being investment grade, or is it just more than returns on capital?

Richard J. Dugas, Jr.

I wouldn’t want to comment on individual debt offerings. What I will tell you is that there are very, very expensive. So as we look at all of our debt over time, if we were to make an investment to buy it back, because we can get some positive yield out of it, and that’s a challenge with some of the pricing that we’re seeing on our paper. Sorry, I forgot the second question. Sorry, Will.

Robert T. O’Shaughnessy

We’ll come back to you, Will.

Operator

Your next question comes from Jay McCanless with Sterne Agee. Your line is open.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Good morning, everyone. First question, what was the [cap rate] (ph) in the quarter?

Robert T. O’Shaughnessy

14.1, so flat with last year.

Jay C. McCanless – Sterne, Agee & Leach, Inc.

Okay, great. And then my second question in a little different take on the lands, can you comment on the valuations you’re seeing in private builders who are willing to sell, and all those valuations in line with what you’re looking forward with the right strategy and could you potentially go out and do some deals and buy some of these private builders to accelerate that land growth that you’re talking about and then is that two building target this year?

Richard J. Dugas, Jr.

Certainly, we see all the transactions that are coming out, the stuff that gets announced, we see these. And I would say the answer is, yes we could potentially be doing transactions, but we’d look at them as typically just a land transaction. So we are putting the same return requirements on them as we are on any particular land transactions in a market.

Oftentimes, when people come to market, they’ve got fairly lost the expectations for price. We haven’t seen anything that was compelling to us to chase, but that doesn’t mean we wouldn’t – we look at them and we’re interested, we’re a buyer and seller of land, it’s part of the equation here.

Operator

Our next question comes from the line of Jim Krapfel with Morningstar. Your line is open.

James Krapfel – Morningstar Research

Hi, good morning. Thanks for taking my question. So using your risk-weighted focus on ROICs, ultimately, where do you see options as a percent of total land under control long-term and how long do you think you’ll get there?

Richard J. Dugas, Jr.

Jim, we’d like to drive option desires we possibly we can. we’ve been really pleased with our ability to do so, given our focus on returns. to some extent, that can be dictated by the seller, in some instances, it’s not available, but Bob, if you have any more color on that.

Robert T. O’Shaughnessy

Yes. The only thing I’d add to that is options can take on different looks and feels. If you’ve got a finished lot option transaction, it’s different than one where you’ve got raw land where you’re optioning partials of it, as you go forward. And for us that can extend it to what generates the best return risk-weighted.

So if we are buying raw land, the option – we want the option to have risk transfer elements to it, whereas if you’re buying finished lots, it’s a little bit simpler to work through. So what we’ve been doing now, we are increasing our percentage of option transaction. but again, they are typically raw, where you may have a 600 lot community and we take the first 200 down and option the second 200.

James Krapfel – Morningstar Research

And on the finished land side, the options of finished land. When do you think you could start to do that to a greater extent? When will the developers regain those naturally held to do those kind of deals?

Richard J. Dugas, Jr.

All right, that’s a great question. And I don’t know.

James Krapfel – Morningstar Research

Okay, next…

Richard J. Dugas, Jr.

I haven’t seen it to a large extent at all today.

Operator

Your next question comes from Dan Oppenheim with Credit Suisse. Your line is open.

Dan M. Oppenheim – Credit Suisse Securities LLC

Thanks very much. I was wondering, it’s great kind of confidence that you talked about in terms of the gross margins during the back half of the year, is that flatter or slightly up. Just wondering about that how much that is the view that the – what you’re doing internally in terms of the common plans and the price optimization is offsetting on the slower home price appreciation and from a high land cost.

Richard J. Dugas, Jr.

Yes, Dan, I think it’s all of the above, I’ll will tell you, I’m very pleased with our internal focus on commonly managed plans and don’t rule out that the stats Bob keeps given each quarter around lot premiums and options those are – and discounts, our internal focus on isolating each of those metrics and trying to optimizing them helps. So it’s clearly a combination of all of the above when you have as many moving parts as we do going in it’s hard to isolate it to anyone, but collectively that’s what where we get.

Daniel Oppenheim – Credit Suisse

Great, and second question you talked about the strong absorption on the Centex side, but then in terms of pricing with Centex it was up less, (indiscernible) achieved in terms of more (indiscernible) lower price points at first to pushing price less in Centex than in many other brands.

Robert T. O’Shaughnessy

Yes, certainly our operators are trying to get price for ever they can, they are also trying to get return and so phases get to there. It’s interesting we were talking earlier, yes the Texas market had outsized first time absorption increases but the non-Texas markets were up 13%. So of that 20 plus percent pace increase it’s not just Texas. So the return characteristics are not so much in that business about generating higher prices be with that buyer is somewhat limited to the down payment they can come up with. So paces what actually replaces it and we’ve seen that across all our markets in this quarter.

Operator

Your next question comes from the line of Stephen East with ISI Group. Your line is open.

Stephen East – ISI Group Inc.

Thank you. Just want to follow-up Richard and Bob a little bit on the cash generation et cetera. As you sit here and look this year and this year and next year before your debt pay down and you repose given the big land spend what do you expect, you should go through on the cash generation side for this year and next.

Robert T. O’Shaughnessy

We haven’t given any color on next year, obviously we’ve been absent debt transaction dividend the share repurchases were going to be cash flow generative this year and substantially. So lot of it will depend on how much of the land spend we actually get done and then how much we allocate to share repurchases.

Stephen East – ISI Group Inc.

Sure, okay. If Richard’s scenario were sort of a slow and steady I mean is it rationale for us to think 215 cash generation before those other issues with sort of be on the similar track.

Richard J. Dugas, Jr.

Steve, we’d hesitate to give a number I think in general we are focused internally on positive cash flow generation given where we are. So that’s clearly among the things that we are focused on.

Robert T. O’Shaughnessy

And certainly we will be – a tax there, next year. So our earnings stream is cash consistent with this year.

Operator

Your next question comes from Buck Horne of Raymond James & Associates. Your line is open.

Buck Horne – Raymond James & Associates

Thanks, I appreciate – the question. I wanted to ask a strategic question because you got good presence with the entry level brand you’ve got to the move-up brands, you’ve got the active adult segments, have you given consideration to moving further upstream whether it’s the second time move-up, we’re taking a full bigger push into the luxury market, have you considered expanding your brand options?

Richard J. Dugas, Jr.

Buck, we’ve talked about it, and this is Richard. We’ve talked about internally and we think the Pulte brand allows us to expand up nicely. as a matter of fact, we have several communities operating in the 6’s and 7’s, and even a couple over a million with that brand just fine. So one of the things we’d recognize is that even though, the margin and return characteristics in that segment are very strong and good, they typically represent above 10% of the total housing market plus or minus. So we think we can serve that very effectively with the Pulte brand.

Buck Horne – Raymond James & Associates

Okay. so you wouldn’t think you need to make an acquisition outside of the company to try to establish a different presence or different brands?

Richard J. Dugas, Jr.

That’s correct. We have enough experience with the Pulte brand and with construction techniques, design et cetera that we believe we can stretch that name into that category. but again, we want to be selective, we like the fact that we are diversified with our portfolio.

Buck Horne – Raymond James & Associates

Okay, thanks.

Richard J. Dugas, Jr.

Thank you. All right. I apologize, Will, I remember your second question and it was about the rating agencies and investment grade. it is certainly the business that we’re running; we think certainly, warrant consideration for investment grade. we’ve shared that our thoughts on that with the rating agencies. The one thing I would say is it’s not the overarching reason we do things. So, again, we think we actually warrant consideration for investment grade today and we’re running the business in the way I think that is supportive of that type of ratings. But it doesn’t mean we wouldn’t look at doing things differently if we thought it was better for shareholders.

Operator

There are no further questions at this time. I’ll turn the call back over to Jim Zeumer.

James P. Zeumer

Great, thank you, operator. I know you have a lot of other calls to be held today. So we’ll be available to have any follow-up questions. Thanks very much for your time and we look forward to speaking with you on the next quarter.

Operator

This concludes today’s conference call. You may now disconnect.

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